A Deep Dive Into BlackRock’s First Active Equity ETFs

The two ETFs sell call options and buy futures.

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Reviewed by: etf.com Staff
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Edited by: James Rubin

BlackRock unveiled the first active equity ETFs in Europe last month as the U.S. giant took another step in the active ETF space.

The ETFs—the iShares World Equity High Income UCITS ETF (WINC) and the iShares US Equity High Income UCITS ETF INCU—offer two distinct geographic exposures while blending the higher end of the actively managed spectrum with the ETF wrapper.

The two products select dividend paying stocks using a rules-based or ‘systematic’ approach while selling call options and buying futures in a bid to generate additional income.

WINC and INCU have total expense ratios (TERs) of 0.35%.

WINC sells call options and buy futures on large and mid-capitalization developed market equity indices, such as the S&P 500, FTSE 100, Nikkei 225, and Euro Stoxx 50, while INCU mirrors the same methodology with the S&P 500 index.

However, the launches are a departure from the many passive high-dividend UCITS ETFs currently available in the European market.

WINC and INCU might be more akin to active giant JP Morgan Asset Management’s equity offerings, however, BlackRock’s use of derivatives separates it.

Active Income

On BlackRock’s decision to sell call options as part of the strategy, Andrew Limberis, investment director at Omba Advisory & Investments, said this might narrow the universe of investors that would buy the product.

“These products are very complex as they use several different financial derivatives,” he said.

“They certainly have not gone for a simple product. The way investors traditionally would be looking at passives is very different to how one would look at this strategy.”

Stephan Kemper, chief investment strategist, team advisory desk, at BNP Paribas Wealth Management, added the European market might have an unjustified hesitation to invest in an ETF that uses derivatives.

“Though I would disagree, many think derivatives are generally bad and this prejudice could make some people suspicious about the product without doing further research.”

Looking at the call options in more detail, Limberis said the ETFs are a couple of percent ‘out of the money’, which may potentially affect additional profits.

Call options have no intrinsic value if the underlying is trading below the cost of the strike price of the call option contract. When buying a call option, the underlying market must rise above the strike price of the option to make a profit.

“They will then really push for income if you are only going a few per cent 'out the money' on the call options,” he added.

Dividend income

Looking at the ETFs’ dividend-generating capacity, Kemper said its “dividend rotation” model could leave them open to being stung by negative market sentiment.

“To use an extreme example, if we are about to have a recession in Germany, but we are close to dividend season in Germany, the model may begin rotating into German equities to get dividends while ignoring market sentiment,” he said.

“This could make you lose much more on the movement of the stock itself compared to the collected dividends.”

In addition, Kemper noted he “struggles” with pure dividend strategies as they ignore buyback yields, a vital part of the total shareholder yield.

Investor View

Both Limberis and Kemper agreed the product would not be a core holding for most investors.

For very specific cases, Limberis noted they could be swapped out neatly if the investor is in a position that requires a high degree of income.

“The ETFs are suited to somebody in early retirement, for example, that needs a bit of income but also wants to stay invested and needs that capital growth from equities,” he said.

“In a very specific case, it could function to some degree as a core allocation, especially the world version. But for the most part, it is about the income you are getting from equities.”

One year ago, Kemper said he might have seen the two products as a core portfolio allocation but today “there are other possibilities to source income”.

“I can still get close to 4% on European investment grade credit, I can still get between 6% and 7% on European hybrids which are issued from investment grade issuers,” he said.

“If you are more of an offensive investor there are other ways to allocate assets nowadays.”

The lack of competing products in Europe may reflect the price point of the two ETFs, particularly the U.S.-focused ETF, Limberis noted.

Even for active strategies, he warned the two ETFs are not particularly cheap, but this can be justified through the more rigorously managed style of the ETF versus other active competitors.

“If they had been a lot more active, they could justify how active they are being and therefore the higher fee,” Limberis said. “They are doing more than existing competitors, at least within the European landscape.”

However, Kemper added: “The price looks reasonable. They are substantially cheaper than any other active solution.”

Active ETFs Rising

Overall, Limberis said the start serves as further evidence of the rise of active strategies in Europe and the appetite for strategies that present an opportunity for a wider positive tracking difference to the benchmark index.

“In Europe, we have active strategies with a much narrower tracking difference. This one seems to be building on that and looks to be a bit more active, which is starting to appeal to different investors.”

Echoing his thoughts, Kemper added the launch signals positive movement for the active ETF space in Europe.

“They are combining two strategies which so far have been purely passive in Europe. This is certainly something to showcase what you can do with active ETFs.”

Looking forward, Limberis said that BlackRock’s launch represents the “first of many” in the active space.

“This strategy is now starting to push the boundaries in terms of tracking error, and we are going to see that extended more over the next 18 months.”

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